UPDATE 5-Bank of England points to 2015 rate rise, blurs guidance

* BoE broadens guidance on rates path to range of indicators

* Bank hints at Q2 2015 timing of first hike

* Carney stands by guidance

By David Milliken and Ana Nicolaci da Costa

LONDON, Feb 12 The Bank of England said on
Wednesday British interest rates could start to rise from record
lows in little more than a year as a rapid recovery brings the
economy closer to operating at full steam.

Governor Mark Carney - forced to ditch a previous version of
rates guidance after it was overtaken by a sharp fall in
unemployment - also announced the Bank would now follow a much
broader range of measures of slack in the economy in making
rates decisions.

The BoE slashed interest rates to 0.5 percent at the height
of the financial crisis in 2009. The economy bounced back
strongly last year but remains smaller than before the crisis
and Carney stressed any increase in rates would be gradual.

"The message to businesses, to households is that the Bank
rate is going to follow a path that is consistent with jobs,
with incomes and with spending growing in a sustainable way," he
said. "We are going to calibrate it carefully. We are not going
to take risks with this recovery."

The central bank said a view in financial markets that rates
could rise in the second quarter of next year - around the time
of a national election - was consistent with its goal to keep
inflation close to its 2 percent target.

It also pointed to market expectations that its interest
rate would stand at 2 percent in three years' time, a timeframe
supported by a Reuters poll of economists taken after the BoE
anouncement.

Sterling hit a two-week high against the dollar and British
government bond prices fell after the Bank's announcement as
investors added to bets on a rate hike next year.

The Bank said it will focus on 18 separate measures of the
spare capacity in Britain's economy, including business surveys
and the number of hours worked, something economists said would
make it hard to guess the BoE's next moves.

The array of indicators contrasted with the guidance adopted
by the BoE last August when it said it would consider whether to
raise borrowing costs only once unemployment fell to 7 percent.

The jobless rate has since tumbled to 7.1 percent. The BoE
forecast on Wednesday it will reach 6.5 percent in early 2015.

"When Bank Rate does begin to rise, the appropriate path so
as to eliminate slack over the next two to three years and keep
inflation close to the target is expected to be gradual," the
Bank said.

The BoE for the first time estimated how much slack is in
the economy - around 1.0-1.5 percent of gross domestic product,
lower than some other economists' estimates.

Deputy Governor Charlie Bean said rates would need to rise
before the spare capacity was completely used up, or the central
bank would risk being behind the curve.

The BoE's dilemma is shared with other central banks in
advanced economies that are healing from the crisis. The U.S.
Federal Reserve is struggling with how to scale back
exceptionally stimulative monetary policy without slowing the
recovery too much.

BACK TO THE FUTURE

The BoE's latest approach to explaining the policy path
ahead represents a partial return to the situation before the
adoption of forward guidance last year. Then, economists
scrutinised small changes in the Bank's inflation forecasts for
signals about whether policy was too loose or too tight.

How the new estimates of slack will influence BoE inflation
forecasts and its policy decisions could prove hard to predict.

Peter Dixon, an economist at Commerzbank, said spare
capacity was a "nebulous concept" and markets would be hanging
on the BoE's judgments. "We have more clarity about one thing,
however - the BoE is determined to keep rates on hold for a long
time to come," Dixon said.

A further complication is that a rate rise now looks most
likely around the date of Britain's next national election in
May 2015, at which public perceptions of living standards look
set to be a key issue.

In the face of some critical questions from reporters about
the credibility of the BoE's new plan, Carney stuck by the BoE's
decision to launch forward guidance last year.

"Forward guidance is working," he said. "Expected interest
rates have remained low even as the economy has recovered
strongly, uncertainty about interest rates has fallen, and most
importantly, UK businesses have understood the message."

The BoE revised up its growth forecast for 2014 to 3.4
percent from 2.8 percent, a much more bullish forecast than that
of most economists.

Inflation has fallen unexpectedly rapidly to its 2 percent
target and the BoE said it expected it to dip further to 1.7
percent by March, before hovering close to 2 percent for the
next couple of years.

The BoE said it was now more pessimistic on the outlook for
British productivity than three months ago, as it had failed to
keep up with rises in output. Business investment was likely to
pick up but increasing exports would remain a challenge.

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